The following item is a Letter of Intent of the government of Madagascar, which describes the policies that Madagascar intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Madagascar, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

1. On July 23, 1999, the Executive Board of the International Monetary Fund approved a second annual arrangement under the Enhanced Structural Adjustment Facility (now replaced by the Poverty Reduction and Growth Facility, or PRGF) for Madagascar. In the context of the first midterm review of the program supported under that arrangement, I have the honor, on behalf of the government of Madagascar, to forward you the memorandum on economic and financial policies for 2000. The memorandum describes the progress achieved in the implementation of the program for 1999-2000, the updated objectives for 2000, particularly those for June 2000, and the policies that will be followed in order to achieve them. The memorandum also describes the devastation produced by the recent cyclones, its impact on the balance of payments, and the reconstruction and external assistance needs. As indicated in the memorandum, the performance criteria on the central bank's net foreign assets and net domestic assets at end-December 1999 have not been observed because of delays in completing the complex process of privatizing the petroleum sector. This delay, in turn,led to postponement of the disbursement of the financial support expected from the World Bank. The shortfall in external assistance has also resulted in the breach of the end-1999 performance criterion on domestic government financing. In the first months of 2000, the government has been able to complete the privatization of the petroleum sector, and the overall financial framework has thus been restored to that originally envisaged under the program. The government is therefore requesting a waiver for nonobservance of these three end-1999 quantitative performance criteria. It is also requesting a waiver for nonobservance of the structural performance criterion requiring correction of the budgetary wage bill for "ghost" workers. This process, which should have been completed by the end of August 1999, required additional analysis of the identified posts and was finalized only during March 2000.

2. The Malagasy government believes that the policies and measures described in the memorandum are adequate to achieve the objectives of its program, but it will take all other measures that may prove necessary for this purpose.

3. In order to allow for the completion of the second midterm review of the program, which will cover, as planned, the implementation of the program in the first half of 2000, the government requests the extension of the three-year PRGF arrangement commitment period until November 30, 2000. It also requests an augmentation of access under the current PRGF arrangement equivalent to 20 percent of quota, in order to contribute to cover the additional financing gap caused by the cyclone destruction.

4. As the memorandum indicates, the government has begun to develop a poverty reduction strategy paper (PRSP) in a participatory context that includes the administration, the private sector, civil society, and development partners. The paper will describe existing poverty, as well as the strategies and the programs planned to reduce it. The government will emphasize the participatory approach of this process and envisages defining the main lines of its strategy in a document that will be prepared by the end of this year.

Sincerely yours,

/s/

Tantely Andrianarivo
Prime Minister
Ministry of Economy and Finance

Attachment: Memorandum on Economic and Financial Policies for 2000

MADAGASCAR

Memorandum of Economic and Financial Policies for 2000

May 24, 2000

I. Introduction

1. In the context of its adjustment efforts to promote sustainable economic growth and reduce poverty, the government of Madagascar adopted a medium-term economic and financial program (1996-99), supported by a three-year Poverty Reduction and Growth Facility (PRGF) arrangement. The three-year arrangement and the first annual arrangement thereunder were approved in November 1996. In the aftermath of elections and a political transition process in 1998, there was a delay in reaching understandings on a program to be supported by a second annual arrangement; the latter was approved by the Executive Board in July 1999 in support of a program covering 1999/2000 (July/June). This memorandum reviews Madagascar's performance through March 2000 under the 1999/2000 program, and outlines the government's objectives and policies for the remainder of 2000.

2. Mainly because of delays in external budgetary assistance and the shortfall in privatization receipts, the performance criteria on the central bank's net foreign assets and net domestic assets at end-December 1999 and on domestic financing of the government at the same date were not observed. On the structural side, the performance criterion at end-August 1999 to reduce the civil service wage bill by eliminating "ghost" workers identified by the April 1999 civil service census was also not observed. This latter exercise, which was to have been completed by August 1999 and was extended to February 1, 2000, was completed in March 2000. During the first quarter of 2000, the authorities took steps to ensure that financial performance is brought back in line with program objectives; accordingly, they are requesting a waiver for not observing these performance criteria.

II. Performance Under the Adjustment
Program in 1999

3. Program implementation for 1999 was satisfactory in terms of economic growth, export performance, and the reduction of the external current account deficit. In contrast, inflation was higher than projected. Based on the most recent estimates, GDP growth reached 4.7 percent, exceeding the 4.5 percent program objective. Growth was generated mainly from the secondary and tertiary sectors, where growth rates of 4.3 percent and 5.5 percent were registered, respectively. Export receipts in SDR terms grew by 13.6 percent, compared with an increase of 4.3 percent in 1998 and a program target of 9 percent. This performance can be attributed to sharp growth in free trade zone exports, and in certain traditional products, such as cloves (which tripled in value) and vanilla (which registered an increase of more than 65 percent). As a result, the external current account deficit, excluding grants, narrowed from 7.9 percent of GDP in 1998 to 6.5 percent in 1999, against a programmed target of 7.3 percent. Including current grants, the deficit declined from 4.8 percent of GDP in 1998 to 2.7 percent in 1999. The performance of the capital account was favorable in 1999 as the result of significant inflows of private capital. A substantial supplier's credit was also obtained by the state petroleum company, SOLIMA. However, nonproject external aid fell short of program projections (SDR 32.9 million, as against SDR 108 million), because of delays in the finalization of structural reforms (including privatization), which were the conditions for disbursements of program loans and grants. Reflecting these developments, net foreign assets of the central bank increased by SDR 39.1 million, against a program target of SDR 99.5 million.

4. On a year-to-year basis, inflation reached 14.4 percent at end-December 1999, compared with a revised target of 11.0 percent. Within the consumer price index, the highest increase was registered by food products and, more particularly meat, as the supply was reduced owing to an epidemic that cut the pig herd by more than half.

5. In the fiscal area, the 1999 program objectives for revenue were ambitious, which was projected to reach 11.9 percent of GDP, equivalent to an increase of 1.3 percentage points from 1998. This increase was to result from a set of measures, most of which were adopted at end-1998, and aimed at strengthening tax and customs administration, eliminating a large number of exemptions from the value-added tax (VAT) and other levies, and increasing excise taxes and levies on petroleum products. The authorities have pursued a determined effort to reach these objectives. End-of-fiscal-year results were largely on target, as shortfalls on profit taxes were offset by higher customs revenue collection. Efforts to strengthen tax and customs administration were carried out as envisaged, including, inter alia, enhanced monitoring of taxpayers and collection of back taxes.

6. In all, current expenditure and the budget contribution to capital expenditure were in line with program projections, although there was a wage bill overrun, amounting to FMG 84 billion (0.4 percent of revised GDP). This is attributable to delays in the repatriation of diplomatic staff, the hiring of new gendarmes, and excess payment of bonuses. Reflecting these developments, overall primary expenditure, excluding externally financed capital expenditure, remained below the overall objective as treasury operations recorded a small surplus, while the program envisaged a small deficit (FMG 29.3 billion). Externally financed capital expenditure was below the program by 1 percent of GDP; interest payments were also lower than projected. As the result of these latter two factors, the overall deficit, excluding grants and restructuring expenditure, was lower than programmed by the equivalent of 1 percent of GDP.

7. The program envisaged expenditure on structural reforms—including privatizations—equivalent to 2.5 percent of GDP in 1999. In the event, these outlays amounted to 1.8 percent of GDP, as substantial privatization operations could not be completed in 1999 as projected. They include the cost to the government of restructuring two banks privatized at end-1998 and end-1999, respectively (approximately FMG 150 billion), indemnification payments to companies (FMG 85 billion), costs sustained in connection with the civil service reform (wage decompression), judicial system reform, and severance payments in connection with the privatization of public enterprises and banks. Privatization revenue, initially projected to reach FMG 758 billion, or 3.4 percent of GDP, amounted to only FMG 52 billion, mainly from the sale of some assets of SOLIMA. In contrast, the sale of the principal assets of SOLIMA (logistics, distribution, and refinery), of the national airline Air Madagascar, and of the telecommunications company, TELMA, could not be finalized in 1999. This, together with the related delay in the disbursement of two tranches under the structural adjustment credit from the World Bank, as well as of other external support, necessitated a recourse to domestic bank and nonbank financing in 1999 of FMG 246 billion, equivalent to 1.1 percent of GDP; the program instead had envisaged a reduction in the government's recourse to net bank credit and, in particular, to net central bank credit. The shortfall in external aid (including debt relief) of SDR 36 million in relation to program projections has resulted in the non-observance of the end-December 1999 performance criterion on domestic financing of the government, as the adjustment factor for a shortfall in external aid was capped at SDR 7.5 million. Commercial banks, which as a result of the August increase in the reserve ratio had little excess liquidity during the latter part of the year, reduced their treasury bill holdings by FMG 94 billion in 1999, despite the increase in the treasury bill rates during the first nine months. However, nonbank subscribers were net purchasers of this paper.

8. Monetary developments in 1999 were characterized by a rapid growth of net domestic assets of the banking system (an increase of 11.1 percent in the 12 months through end-December, equivalent to 8.5 percent of the money supply at the beginning of the period before bank restructuring). The growth is the result of a higher-than-programmed increase in net credit to government (2.8 percent of beginning-of-period money stock, compared with a programmed decline of 19.5 percent, before bank restructuring) and a strong demand for credit from the private sector; the latter grew by 19.1 percent during the same period, excluding bank restructuring operations. To accommodate this demand, commercial banks operated with very low liquidity reserves until November. To curtail the increase in credit to the economy, contain inflationary pressure, protect the balance of payments, and encourage purchases of government paper, the central bank raised its key interest rate twice—from 10 percent to 12 percent in April, and to 15 percent in August. These increases led to a parallel adjustment in treasury bill and bank lending rates. Liquidity increased only in December, as the result of seasonal repayment of crop credit. A slight reduction in treasury bill rates was registered during the fourth quarter of the year.

9. During the first quarter of 2000, the central bank and treasury agreed to absorb excess liquidity from commercial banks and reduce net central bank credit to government. Accordingly, during that period, the volume of treasury bills issued exceeded the treasury's own financing needs and interest rates remained broadly stable. The proceeds from these issues enabled the treasury to repay fully, at end-February, the statutory advances from the central bank, which amounted to FMG 197 billion at end-1999.

10. The increase in the central bank's net foreign assets in 1999 (SDR 39.1 billion, or 11 percent of beginning-of-period money stock) fell short of the program target (SDR 99.5 million) as a result of delays in privatization operations and related external aid disbursements. At the same time, the increase in net domestic assets of the banking system exceeded the programmed amount. Reflecting these developments, the money supply grew by 19.5 percent, against a programmed target of 8.8 percent.

11. In 1999, the authorities made significant strides in carrying out the envisaged structural reforms. Thus, theycompleted the privatization of the commercial bank BTM, adopted a law on arbitration procedures, published a decree regarding telecommunications interconnections between fixed and cellular operators, approved a new Mining Code, increased fishing license fees by 100 percent on average from 1998, and introduced a new budget nomenclature to harmonize budget accounts and treasury cash management. However, there were delays in privatizing SOLIMA and Air Madagascar —two key actions needed to release the first and second tranches of the second structural adjustment credit (SAC II) from the World Bank.Preliminary agreements for the sale of the main components of SOLIMA1 were signed in 1999; however, the asset transfers were not finalized, and the new companies did not effectively begin operation as planned because understandings could not be reached with the investors on some environmental and legal issues, and on the effective date for the new price formula adopted in December 1999.2 All of these issues were resolved in May 2000, allowing the transfer of ownership to be finalized. The delay regarding Air Madagascar was caused mainly by the need to reach an agreement with a creditor on the release of a lien on one of the company's aircrafts at reasonable terms and in line with Paris Club guidelines. This agreement is expected to be reached during 2000.

12. Significant reform was introduced in the shrimp sector prior to the start of the 2000 season. In particular, a new transparent, nondiscretionary, and competitive system for managing fishing licenses and assessing the relevant fees was implemented. This auction-based system, which will be published in the Official Gazette in 2000, enabled (i) a significant increase in fees collected from the sector; (ii) a redistribution of the allowable catch among the four newly created areas; and (iii) the elimination of exclusive areas. With regard to the overall fishing exploitation, a freeze at 69 licenses for the west coast was agreed, pending completion of a scientific study on the sustainable potential for fishing. Under the freeze, two new licenses may be issued for the development of autonomous provinces based on a transparent, nondiscretionary, and competitive procedure. The authorities expect the introduction of this new management system to substantially enhance good governance practices.

III. Economic and Financial Policies
for 2000

13. For 2000, the main macroeconomic objectives were revised to take into account the destruction caused by the three cyclones that hit the country during February-April. Accordingly, the GDP growth rate, originally projected to reach 5.3 percent, is now expected to rise by 4.8 percent, as a result of the destruction of export crops and rice production. According to provisional estimates, gross fixed capital formation could increase from 13 percent of GDP in 1999 to 16 percent in 2000 because of a steady improvement in the industrial and commercial environment and the reconstruction effort. Through prudent monetary and fiscal policies, the government plans to limit inflation, which increased sharply in 1999, to less than 10 percent on an annual basis at end-2000. The attainment of this objective may be facilitated by favorable developments in the supply of key products, such as foodstuff and petroleum.

14. The cyclones, particularly the third one that hit the northeastern part of Madagascar in early April, has caused the loss of many lives, the destruction of tens of thousands of houses and extensive damage to schools, health centers, and the communication network, including ports and railways. In addition, the export crops of coffee, vanilla, and cloves are expected to be affected following the heavy damage inflicted on the plantations as well as on the irrigation networks and the rural roads. To address the pressing needs arising from this destruction, Madagascar needs emergency aid, construction materials and financial support to contain the deterioration of the balance of payments. The humanitarian emergency needs are estimated at US$16 million for the third cyclone. The reconstruction costs, including the social infrastructure but excluding the administrative buildings, are estimated on a preliminary basis at about US$120 million. This amount reflects the need to rebuild the damaged infrastructure according to anticyclonic norms. World Bank and AfdB missions are currently assessing the costs of reconstruction to provide an estimate of the medium-term investment need, and the related annual tranches. The investment effort will need to be financed mainly by external resources on a provisional basis. The reconstruction needs for 2000 are estimated at FMG 200 billion, of which FMG 160 billion is expected to be covered by external assistance, and FMG 40 billion by additional domestic financing.

15. With regard to the current account of the balance of payments, the first estimate of the cumulative damage from the cyclones indicate that in 2000 exports may fall short by about SDR 22 million from the original estimates of SDR 478 million. Accordingly, export growth in value terms in 2000, originally estimated at 10 percent, may be limited to 5 percent. As for imports, in 2000 the cyclone-related damage to local production of rice (which is now estimated to be 6.4 percent lower than the original estimate of 2,700,000 tons) will require higher imports of rice by about 120,000 tons, with an additional cost of SDR 20 million. The additional need in imports of equipment goods is estimated at SDR 10 million. In all, the additional financing gap in the balance of payments is estimated at SDR 51 million; the original estimate of the gap was SDR 17 million, and was expected to be covered by additional debt relief. The external current account deficit, excluding grants, which amounted to 6.5 percent of GDP in 1999 (5.5 percent including current grants) is expected to rise to 9.1 percent of GDP in 2000 (7.7 percent including current grants). The authorities wish to cover this additional financing gap of SDR 51 million by requesting (i) an upfront augmentation of access to the Fund under the existing PRGF arrangement for an estimated amount of SDR 24.4 million (equivalent to 20 percent of quota); (ii) supplementary assistance from the World Bank; and (iii) additional debt service relief from Paris Club creditors and other bilateral creditors. Provided this additional financing and the emergency

disbursements requested by the authorities from multilateral creditors to fund the reconstruction efforts (SDR 18 million in 2000) become available, the net foreign assets of the Central Bank could increase during the year by SDR 46.5 million, compared with the initially projected increase of SDR 71 million (which reflected substantial privatization receipts).

A. Public Finance

16. The budget law for 2000, approved by the National Assembly at end-1999, is based on budgetary targets in line with the program and includes a set of measures adequate to achieve them. However, the authorities had to take supplementary measures to address exceptional developments related to the resurgence of a cholera epidemic and the devastating effects of recent cyclones. The budgetary cost of these emergency measures is estimated at 0.3 percent of GDP. Similarly, the increase in international petroleum prices and the upward revision of profit margins in connection with the privatization of the petroleum sector require substantial consumer price increases. The authorities adjusted in 1999 domestic prices upward by an average of 30 percent, and intend to continue to pursue a policy of adjusting prices gradually during the course of 2000, to ensure that the price increases are socially acceptable. Accordingly, a first price increase took effect on March 18, 2000. The gradual price adjustment policy implies in 2000 one-off budgetary charges (at an estimated cost of 0.8 percent of GDP) to compensate petroleum sector operators. All budgetary revisions will be incorporated into a supplementary budget to be submitted to the National Assembly during the first session of 2000.

17. The revised fiscal program for 2000 aims at a fiscal deficit (on a commitment
basis, and excluding grants, the costs of structural reforms, exceptional
expenditure, and the reconstruction costs) of 5.5 percent of GDP, compared
with an original targeted deficit of 4.9 percent. This revised
deficit target reflects the implementation of the structural reforms
and the revised timetable of aid disbursements by the main donors and
lenders. Attainment of the revised deficit target is based on a budgetary
revenue target of 12.7 percent of GDP, as against 11.4 percent
in 1999. At the same time, noninterest current expenditure, which includes
a larger allocation for social sectors, is to decline slightly from
7.2 percent of GDP in 1999 to 7.0 percent in 2000, owing to a slight
reduction in the wage bill as a share of GDP. Including the emergency
expenditure and the treasury operations outlined above, total current
expenditure is expected to amount to 9.9 percent of GDP. The public
investment program, excluding the reconstruction expenditure, provides
for a substantial increase in capital expenditure as a share of GDP,
from 6.9 percent in 1999 to 8.2 percent in 2000. Of this total, externally
financed projects account for 5.6 percent of GDP (4.9 percent
in 1999). In 2000, reconstruction expenditures are projected to reach
FMG 200 billion, or 0.8 percent of GDP. The reconstruction program
will cover a three-year period, and will be finalized in close coordination
with foreign donors. With total expenditure expected to reach 18.8 percent
of GDP, the overall deficit, on a commitment basis including grants
(excluding restructuring operations) is projected at 1.4 percent
of GDP including grants. The cost of other structural reform expenditures,
in addition to the above-mentioned compensation for petroleum sector
operations (i.e., privatizations, civil service, including decompression
and justice system reforms, and indemnification of foreign owners),
is equivalent to 2.2 percent of GDP; this has been taken into account
in the program and the budget law.

18. As a result, the total overall fiscal deficit on a cash basis, and including the net cost of structural reform is projected at 4.5 percent of GDP. Taking into account revenue from privatization (2.3 percent of GDP) and projected external budgetary assistance (3.0 percent of GDP), the program will enable the government to reduce significantly its debt to the banking system.

19. Tax revenue is projected to reach 12.2 percent of GDP in 2000. This objective reflects not only the full-year impact of some measures taken in the course of 1999 (equivalent to 0.4 percent of GDP) but also a set of measures comprising (i) the introduction of a synthetic tax applicable to small taxpayers and the informal sector and the levy of a statistical tax on imports (0.4 percent of GDP); (ii) the streamlining of import duties; (iii) the application of the normal tax regime to taxpayers whose exemption arrangements under the Investment Code are expiring; (iv) the accelerated collection of arrears; and (v) intensified efforts to eliminate sales and purchases without invoices. The tariff structure under the 2000 budget law was simplified with the elimination of two rates. The structure now includes only four nonzero rates (5, 15, 25, and 30 percent); the number of products subject to the 30 percent rate will be gradually reduced. Furthermore, a reallocation of products among the four rates was introduced with the aim of ensuring a more coherent tariff structure. These measures are consistent with the objectives of the Cross-Border Initiative (CBI). In this connection, the 80 percent tariff reduction that has been in effect since September 6, 1999 for Mauritius and the Comoros was brought to 100 percent on January 1, 2000. For other member countries of the Common Market for Eastern and Southern Africa (COMESA), the necessary steps were taken to implement the preferential trade arrangements, involving a 90 percent tariff reduction.

20. The tax and customs administrations will continue to be strengthened so as to permit the attainment of the revenue targets. On the customs side, the strengthening of the computerized customs system, SYDONIA, should be completed during the year, and the interface with the preshipment inspection company (to reconcile revenue with the company's estimates) will be improved. The control of special customs regimes will be tightened. Concerning domestic tax administration, the authorities are strengthening the large enterprises unit and the regional administrations following the favorable experience in tax assessment and recovery in the two existing regional centers. The staff of the customs tax administration and the treasury will be increased to improve their operational capacity.

21. The expenditure policy for 2000, excluding reconstruction outlays, reflects the government's key priorities (social sectors, infrastructure, and civil service reform). Budget appropriations for nonwage current expenditure for the social ministries are expected to reach 0.7 percent of GDP in 2000, up from 0.6 percent in 1999. The budget of the Ministry of Budget and Development of Autonomous Provinces includes an allocation of FMG 21 billion (0.1 percent of GDP) to support local government expenditure on basic education and health. Appropriations for the Ministries of Health and Education, including those that are earmarked for the municipalities, will be released on a quarterly basis. Mechanisms to monitor such expenditures have also been introduced in cooperation with the World Bank and the European Union at the municipality level.

22. Regarding the civil service reform, there were delays in eliminating from the civil service roster the 'ghost' workers identified during the physical civil service census completed in April 1999. These delays were attributable to the complex verification procedures that were required. This review of the payroll was finalized in March 2000. As part of the overall civil service reform, the authorities are working on a system of performance-related bonuses, to be implemented from the second half of the year, and budgeted in the amount of FMG 32 billion. During the third quarter of 2000, the government will adopt the new civil service staff statutes, to be submitted to the National Assembly during its second session in 2000. The new statutes will include, inter alia (i) a reduction in the number of special civil service regimes; (ii) a new merit-based remuneration system; and (iii) a code of ethics and discipline. Concerning the reorganization of six pilot ministries, the government has identified the key positions for which specific tasks will be defined, with a view to introducing a merit-based career management and performance-based remuneration. The redefinition of the organizational structures for these ministries, which began in 1998, is still in progress; it will be completed when the legal framework for decentralization, presently in preparation, has been finalized.

23. In 2000, the authorities intend to submit to the National Assembly the first statutes defining the legal framework for decentralization (autonomous provinces, regions, and municipalities) and the relations among the various levels of government, in accordance with the constitution. The authorities intend to pursue a policy of gradualism in putting these provisions into effect and will carry out the transfer of authority and financial resources gradually, so as to avoid disruptions in the management of public resources.

24. In 2000, external budgetary support, excluding the support for reconstruction, is projected at SDR 88 million (3.0 percent of GDP), including two disbursements under the SAC II of the World Bank (SDR 40 million), disbursements from the African Development Bank (SDR 11.4 million), budgetary assistance from the European Union (expected to amount to SDR 32 million), and funding from bilateral donors and lenders. External debtservice relief from bilateral creditors is projected at SDR 37 million (1.3 percent of GDP). Concerning the financing of reconstruction expenditure, the main external sources have already been identified. They include mainly international organizations such as the World Bank, the African Development Bank, and the European Union, and some bilateral donors. The expected quarterly flow of external budgetary support and debt relief are presented in Table 1. On the basis of prudent estimates, privatization revenue is projected at FMG 595 billion (2.3 percent of GDP). These projections reflect the expected finalization of the sale of SOLIMA during the second quarter of 2000 and of Air Madagascar during the third quarter of the year. These privatizations should enable the government to reduce in 2000 its debt toward the banking system by close to FMG 382 billion. The repayment of central bank credit may exceed this level as the result of the net subscription of treasury paper by commercial banks.

B. Monetary and Credit Policy

25. Monetary policy will continue to be directed primarily at containing inflation and strengthening the central bank's net foreign assets. The monetary program for 2000 is based on money supply growth of 10 percent, as against 19.3 percent in 1999, under the assumption of a stable velocity of circulation over the two-year period 1999-2000. The central bank will continue to closely monitor base money and the money supply, and its net domestic assets and operations in the treasury bill market will remain the key instruments for conducting monetary policy. Continued fiscal consolidation, together with the resumption of foreign aid disbursements and substantial privatization receipts from abroad, is expected to facilitate a rebuilding of the central bank's net international reserves and a reduction of the banking system's net credit to government, while leaving adequate scope for private sector credit expansion. In 2000, net foreign assets are projected to increase by 9 percent of the initial money stock, net bank credit to government is expected to decline by 7.7 percent of the initial money stock, and credit to the private sector is projected to increase by 26 percent.

26. Net bank credit to the government by the central bank and the whole banking system will decline sharply in 2000; according to initial forecasts, this decline was projected to reach FMG 422 billion (8.5 percent of the initial money stock) for the banking system as a whole. Since in addition to the support of multilateral institutions, the government's budget will have to contribute to the reconstruction effort, there is a need for an additional FMG 40 billion in domestic bank financing to the government. This financing will originate mainly from the central bank, as the commercial banks will need to provide some additional credit to the private sector operators have been adversely affected by the cyclones. On the basis of these revised projections, the government's repayment of net bank credit will amount to FMG 382 billion (7.7 percent of initial money stock); its repayments to the central bank will amount to FMG 497 billion. The central bank's intervention in the foreign exchange market will continue to be limited to achieving its net foreign asset targets and to smoothing fluctuations, with the possibility of additional purchases of foreign exchange in case of upward pressures on the Malagasy franc, as indicated in the June 28, 1999 memorandum on economic and financial policies for 1999-2000. The central bank will gradually lower the reserve requirement, taking into account the liquidity situation and credit demand.

27. The policy governing the issuance of treasury bills will reflect monetary policy objectives. This will require close consultation between the central bank and the treasury, which will regulate the issuance of treasury bills to accord with the programmed financing requirements and the need for managing the banking system's liquidity situation. The treasury's priority during the year will be to repay the central bank's advance in foreign exchange (equivalent to FMG 545 billion at end-1999)—of which two thirds would be reimbursed by the end of the year.

28. The restructuring and privatization of the second public bank, the agricultural bank of Madagascar (BTM), were finalized during the fourth quarter of 1999. The government continues its vigorous efforts to collect the nonperforming loans of this bank and of the first privatized bank (BFV), which have been transferred to debt-workout units (Société Générale de Recouvrement, or SGR, and Société Financière de Réalisation or SOFIRE, respectively). The aim is to recover a substantial share of the restructuring costs of the two banks and to send a clear signal on the enforcement of contractual rights. Following up on notification letters sent to the delinquent debtors of the BFV and BTM in mid-1998, the names of delinquent debtors with SOFIRE were published in June 1999; this list is regularly updated. The same procedures are being followed for delinquent debtors of the BTM, for which a list is being prepared for publication during 2000. The government has also taken important steps to strengthen the jurisdiction of the special administrative courts for loan recovery. In this connection, (i) Law 99-024 on provisional judiciary liens (hypothèque judiciaire provisoire) was adopted on August 19, 1999 to protect the interests of creditors; (ii) the Ministry of Justice is monitoring, on a monthly basis, legal developments in cases submitted to the special courts; and (iii) it is continuing to emphasize to judges that court decisions should be swiftly enforced.

29. Measures will be adopted in the course of 2000 to reinforce the soundness of the banking and financial system, reflecting the recommendations of the November 1999 IMF technical assistance mission that examined the conformity of Madagascar's banking regulations with the Basel Core Principles. In particular, (i) the amount of loans extended to a single borrower will be reduced gradually from 40 percent to 30 percent of a bank's own capital and reserves; (ii) solvency ratios will be kept in line with international standards; (iii) the central bank will issue new instructions in 2001 on the requirement for all banks to implement a permanent internal audit system, subject to systematic review by the Banking and Financial Supervision Commission (CSBF); and (iv) a mechanism will be studied to achieve a more efficient execution of bank guarantees and collateral. Financial institutions—in particular, credit unions and institutions in the emerging microfinance sector—will be governed by prudential regulations and effective supervision similar to those applicable to banks. Furthermore, the government launched a program in 1999 to modernize the insurance sector. Accordingly, a revised Insurance Code was adopted in September 1999 establishing a competitive and market-oriented framework. On the basis of a financial and technical audit of the insurance sector, to be completed in 2000, the process of privatizing one of the two state-owned insurance companies will be launched during 2000, while the other privatization is scheduled for 2001. Furthermore, an organizational, financial, and actuarial audit of the social security system (CNAPS) and the civil service pension scheme (Caisse de Retraites Civiles et Militaires, or CRCM, and Caisse de Prévoyance et de Retraite or CPR) was initiated and will be completed as scheduled in the second half of 2000, thereby paving the way for subsequent reforms.

C. External Sector and Debt-Management Policies

30. The balance of payments projections indicate that, even though the terms of trade worsened as the result of the increase in petroleum prices and its negative impact on the trade balance, the overall balance is expected to strengthen because of foreign direct investment flows and the continuation of significant private transfers. Nevertheless, the external financing gap remains substantial; it is expected to be filled, as indicated above, by project financing, budgetary assistance from multilateral institutions, bilateral donors and creditors, and debt relief. The Paris Club has extended Madagascar's rescheduling agreement (signed in March 1997) from December 1, 1999 to July 31, 2000. The government will request an extension of this agreement to cover all of 2000, concurrently with an extension of the PRGF arrangement with the Fund.

31. Given the country's heavy debt burden, the government will not contract or guarantee any new nonconcessional loans except for short-term import credits. It will remain current on its external debt obligations and will not incur any new arrears on external payments. It will also normalize its relations with creditors by concluding the agreement with Russia within the Paris Club framework, and seeking comparable agreements with other bilateral creditors. In this connection, a rescheduling agreement was concluded in September 1999 with the Kuwaiti Fund for Arab Economic Development, and negotiations are in progress with the Saudi Fund for Development and Abu Dhabi Fund for Arab Economic Development. Madagascar expects to reach the decision point under the Initiative for Heavily Indebted Poor Countries (HIPC Initiative) in 2001, which will enable it to benefit from substantial debt-service relief and thereby strengthen its poverty reduction action plan.

32. The authorities are strengthening the debt-management system and plan to introduce the SYGADE system in the near future, with assistance from the UN Conference on Trade and Development (UNCTAD). They are in the process of reconciling debt data with all creditors.

33. The government is steadily pursuing trade liberalization under the CBI, as discussed above. With regard to the customs tariff, the maximum rate of 30 percent is the only difference between Madagascar's system and the three-rate system (5, 15, and 25 percent) that the authorities undertook to implement in accordance with CBI objectives. The authorities are determined to reclassify goods subject to the 30 percent rate gradually, taking into account budgetary objectives. The reciprocal preferential tariff system under the CBI, which is now in force for Mauritius and the Comoros (100 percent duty reduction) will be expanded in the coming months to cover a number of other countries that have decided to apply the principle of reciprocity.

D. Structural Policies

34. The structural reform program adopted by the government focuses on providing a favorable environment and regulatory framework for the development of the private sector, including foreign direct investment. During 2000, the program will continue to center on (i) privatization of key public enterprises; (ii) modernization of the legal framework and strengthening of the judicial system; and (iii) development of certain potential high-growth sectors, such as mining, fishing, and tourism.

35. In the area of privatization, the government intends to complete in coordination with the World Bank, the privatization of Air Madagascar and several major enterprises, such as the shipyard (SECREN) while moving forward with the privatization of more of the 46 originally listed enterprises. In the telecommunications sector, the program aims to complete the preliminary work for the privatization of TELMA at the beginning of 2001 and, following this privatization, to launch calls for a second fixed telecommunications network operator.

36. The reforms under way to promote private sector development—in
particular, the improvement of the legal system, simplification
of company registration procedures, and the overhaul of the business
law—will be accelerated in 2000.

IV. Poverty Reduction Strategy

37. The policies undertaken by the government during recent years and supported by Madagascar's development partners have aimed at reducing poverty while maintaining a stable macroeconomic environment and securing conditions for sustainable development. The government intends to strengthen this approach with the support of the Bretton Woods institutions and the Heavily Indebted Poor Country (HIPC) Initiative.

38. In this connection, in cooperation with donors and lenders, the government has initiated the work required to develop a national poverty reduction strategy. An update of studies on poverty in Madagascar has been undertaken to define specific objectives and to prepare a draft strategy for poverty reduction by the end of the year. The latter will be done through a participating process, with the involvement of local governments, civil society and social partners, donors and lenders, thus ensuring that the final strategy will be fully internalized and owned. The government has undertaken to define social sector indicators in order to monitor the results of implementing this strategy. Debt-service relief resulting from the HIPC Initiative, from which Madagascar wishes to benefit as soon as possible, will support action plans in priority sectors. These action plans will be costed and quantified, and their implications incorporated into the government budget.

V. Program Monitoring

39. To monitor the implementation of the 1999-2000 annual program, the quantitative benchmarks and performance criteria at end-June 2000 were updated, as indicated in the attached table. The authorities will conduct the second program review with the IMF by end-September 2000. This review will cover economic and financial developments during the first half of 2000 and the outlook for the rest of the year. The review will establish the basis for further IMF support to the government's medium-term program, which could be in the form of a new arrangement under the PRGF.

1 In the context of its privatization,
SOLIMA has been subdivided into several components, including refinery,
distribution, aviation, logistics, and motels.

2 To align domestic prices
for petroleum products with those on the international market, the authorities
increased prices initially in March 2000, to be followed by a second
increase during the course of the year.